ABSTRACT: Arrow (1962) showed that a secure monopolist (unconcerned with
preemption) has a weaker incentive than would a competitive firm to
invest in a patentable process innovation. This paper shows that the
ranking can be reversed for product innovations. Only the innovator
sells the new product, a differentiated substitute for the old. Under
alternative market structures considered, the old product is sold only
by that same firm (two-product monopoly), only by a different firm
(post-innovation duopoly), or in perfect competition. In an asymmetric
Hotelling model, the innovation incentive under monopoly is greater
than under duopoly if and only if the new product has the higher
quality, and is always greater than under perfect competition.